Friend, Not Foe? Monetary Policy and Energy Prices

Abstract

We empirically show that a central bank’s ability to affect global energy prices crucially alters monetary policy transmission. Drawing on high-frequency event-study evidence and a Bayesian proxy structural VAR for the euro area, we find that an unexpected tightening by the ECB leads to a strong and persistent decline in global oil prices and in consumer energy prices. Employing a Lucas critique-robust counterfactual framework, we document that this channel strengthens and accelerates transmission to inflation and roughly halves the sacrifice ratio. We further show that the central bank’s ability to influence energy prices materially shapes the mandate-optimal response to an energy supply shock: when energy prices are endogenous to policy, the optimal reaction features a smaller interest rate increase and a more favorable inflation-output allocation than in a scenario where energy prices are unaffected by monetary policy.